Chapter 9 - asset Pricing Models

Chapter 9 - asset Pricing Models - 9-1Chapter 9Charles P....

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Unformatted text preview: 9-1Chapter 9Charles P. Jones, Investments: Analysis and Management,Tenth Edition, John Wiley & SonsPrepared byG.D. Koppenhaver, Iowa State UniversityAsset Pricing ModelsCapital Allocation Across Risky and Risk Free Portfolios Fact: Bonds are riskier than T-bills and stocks are riskier than bondsCapital allocation decision between risk free and risky assets is probably the most important oneIt can account for an astonishing 94% of the differences in total returns achieved by institutionally managed pension funds John C. Bogle, Bogle on Mutal Funds, Irwin Professional Publishing 19948-29-3Capital Asset Pricing ModelDeveloped by William Sharpe (1964), John Lintner (1965) and Jan Mossin (1966)Focus on the equilibrium relationship between the risk and expected return on risky assetsBuilds on Markowitz portfolio theoryEach investor is assumed to diversify his or her portfolio according to the Markowitz model9-4CAPM AssumptionsAll investors:Use the same information to generate an efficient frontier Have the same one-period time horizonCan borrow or lend money at the risk-free rate of returnNo transaction costs, no personal income taxes, no inflationNo single investor can affect the price of a stockCapital markets are in equilibrium 9-5Borrowing and Lending PossibilitiesRisk free assets Certain-to-be-earned expected return and a variance of return of zero (i.e. RF=0)No correlation with risky assetsUsually proxied by a Treasury securityAmount to be received at maturity is free of default risk, known with certaintyAdding a risk-free asset extends and changes the efficient frontier9-6RiskBATE(R)RFLZXRisk-Free LendingRiskless assets can be combined with any portfolio in the efficient set ABZ implies lendingSet of portfolios on line RF to T dominates all portfolios below it9-7Impact of Risk-Free LendingIf wRF placed in a risk-free assetExpected portfolio returnRisk of the portfolioExpected return and risk of the portfolio with lending is a weighted average))E(R-w(RF w) E(RXRFRFp1+=XRFp)-w(1=9-8Borrowing PossibilitiesInvestor no longer restricted to own wealthInterest paid on borrowed money...
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This note was uploaded on 06/02/2011 for the course FINA 3331 taught by Professor Staff during the Spring '08 term at Texas A&M University, Corpus Christi.

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Chapter 9 - asset Pricing Models - 9-1Chapter 9Charles P....

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